Looking For Risk in All the Wrong PlacesContingent LiabilitiesBy Steven Kozack

Credit professionals routinely request, receive and review financial
statements from their larger customers. Typically, credit professionals
will request a Balance Sheet, Income Statement and Cash Flow Statement.
Unless the creditor also receives and reads the Notes to the Financial
Statements, they are going to miss an important key to proper risk
management - information about contingent liabilities.

What are contingent liabilities? A contingent liability is a potential
claim against a company for which any actual or direct liability
is dependent upon some future event or circumstance. Confused? Here
are some alternative definitions:

A potential obligation that arises from past events and whose
existence will be confirmed only by the occurrence of one or more
uncertain future events not wholly within the company's control;
or

A present obligation that arises from past events but is not
recognized because it is not certain that a transfer of assets
will be required to settle the obligation; or the amount of the
obligation cannot be measured with sufficient reliability.

A liability that is difficult to quantify, or that may or may
not come to pass.

Here is an example of a contingent liability. A lawsuit is filed
against a company. The company does not list the amount demanded
by the plaintiff as a liability because the company is uncertain
as to the outcome of the case. Nevertheless, from the point of view
of a credit professional evaluating the risk associated with extending
credit to that company it is important to know:

Whether or not the company has insurance that covers this type
of contingent liability

Whether or not the insurance will cover the entire amount if
it determined that the company owes the claimant the entire amount

When the question of the validity of the contingent liability
is likely to be determined

What can credit professionals do to reduce the risks associated
with contingent liabiities? Creditors should [a] always ask customers
for Notes to the financial statements, and [b] should take the time
to read these Notes carefully. If there are any questions or concerns,
the creditor should ask for additional information about contingent
liabilities.